It’s a marathon, not a sprint. First stop, Subsidies

It’s a marathon, not a sprint. First stop, Subsidies

In his inaugural address, President Bola Ahmed Tinubu set a tone that was remarkably resolute and left little room for ambiguity – “The fuel subsidy is gone”. Three days later and the state oil company – the Nigerian National Petroleum Corporation Limited (NNPCL) – has nearly tripled petrol prices across its retail outlets, from ₦185 ($0.40 @ ₦461/$) per litre to ₦488 per litre ($1.05) in Lagos (Nigeria’s Commercial hub in the South West) and to as high as ₦547 ($1.18) per litre in Maiduguri (one of the farthest cities in the North East). Crucially, the new prices have dispersed the long queues that formed at filling stations to an extent and ostensibly reduced the incentive for smuggling petrol across the border as prices in sub-Saharan Africa (SSA) typically range between $1.10 and $1.29 per litre (₦507.1 – ₦594.7 @ ₦461/$).

Discarding the decades-long subsidy scheme is one of several reforms that the president has pledged to embark upon. He has also called for a unification of the exchange rate, clearly signalling that he is pro-reform and pro-markets, which is fuelling investor excitement. On the first trading day following the inauguration, the equities market experienced a significant upswing, with a gain of 5.23% (₦1.508 trillion), marking the largest single-day gain in two years. This surge has resulted in a year-to-date (YtD) positive return of 8.77%.

The prevailing narrative suggests that scrapping petrol subsidies (estimated at ₦4.8 trillion in 2022) would enable the redirection of resources towards enhanced public infrastructure, education, and healthcare investments. However, considering the increasingly widening fiscal deficit (estimated at 5.2% of GDP – higher than the fiscal guidance level of 3%)  and with an estimated 96% of government revenues in 2022 spent on debt servicing obligations, what we hope for is a narrowing of the deficit, which would lower the pressure to borrow money – sharpening the efficacy of fiscal policy instruments.

It is noteworthy that the NNPCL remains the exclusive importer of petrol as it has access to foreign exchange at official prices, currently around ₦465/$, which is an aberration as it is expected to supply no more than 30% of Nigeria’s petrol consumption based on the provisions of the Petroleum Industry Act (PIA). Although the corporation is yet to disclose the specifics of its price determination framework, we anticipate that the retail prices it establishes will serve as a benchmark for petroleum marketers to follow.

Price Stability hanging in the balance

Many Nigerians are yet to come to terms with the reality of cost-reflective petrol pricing as intra-city transport fares soar and inflation expectations follow suit. Exchange rate unification, which we estimate will move the naira to somewhere between ₦630/$ and ₦700/$, would lower the cost of imports and ease the pressure from imported inflation. This is particularly positive for raw material importers and buyers of diesel. However, it would lead to further increases in the price of imported petrol, which would raise food prices significantly. As a consequence, we envisage further increases in headline inflation to 25.5%, and an average of 23% in 2023.

Figure 1: Annual Average Inflation (2012 – 2023f)

Source: National Bureau of Statistics (NBS)

This may hamper the Central Bank of Nigeria’s (CBN) effort to rein in inflation, which has surged to an 18-year high of 22.2% in April 2022 from 16.82% just a year ago. As a result, the CBN could maintain its tightened monetary stance, as it has done since May 2022, and continue to hike the monetary policy rate (MPR), thereby further increasing borrowing costs for businesses and constraining economic activity, which slowed substantially in Q1’23 to 2.31%. As an added complication, the president’s position – “Interest rates need to be reduced to increase investment” – runs counter to the anticipated increase in interest rates.

For households, already confronted with stagnating real incomes, further cost increases are expected – transport, food, rent, school fees, amongst others. With more resources allocated to necessities, discretionary income will decline, and with it, the outlook for certain sectors of the economy – such as consumer goods – as the impact of the shock to consumption becomes more apparent. Amid an expected decline in aggregate consumption, many businesses will be confronted with higher production and distribution costs, which are likely to be passed on to consumers in the form of higher prices. Nonetheless, these will be offset by the impact of lower import costs. Perhaps the biggest winner is the downstream segment of the oil and gas industry. The removal of subsidies effectively lifts the cap on earnings, which should attract investment and improve efficiency. As a result of this initiative, there is potential for increased revenue generation and subsequent tax contributions to the government.

We expect renewed and heightened calls for palliatives, cuts to the cost of governance and improved transparency in the management of public finances. The government’s initiation of the national minimum wage review process is likely to encounter heightened demands for expeditiousness. However, the current fiscal limitations may render it impractical in the near term. Numerous organisations have adopted hybrid work models, driven by cost optimisation initiatives and accelerated by the COVID-19 pandemic. It is expected that these businesses, among others, will increasingly prefer remote work arrangements in light of the anticipated escalation in transportation costs. Nigerians may just have to tighten their belts as the road to reform will most likely be long and arduous.

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